U.S. may buy stake in banks

Having tried without success to unlock frozen credit markets, the Treasury Department is considering taking ownership stakes in many U.S. banks to try to restore confidence in the financial system, according to government officials.

Treasury officials say the just-passed $700 billion bailout bill gives them the authority to inject cash directly into banks that request it. Such a move would quickly strengthen banks' balance sheets and, officials hope, persuade them to resume lending. In return, the law gives the Treasury the right to take ownership positions in banks, including healthy ones.

The Treasury plan, still preliminary, resembles one announced Wednesday in Britain. Under that plan, the British government would offer banks like the Royal Bank of Scotland, Barclays and HSBC Holdings up to $87 billion to shore up their capital in exchange for preference shares. It also would provide a guarantee of about $430 billion to help banks refinance debt.

The American recapitalization plan, officials say, has emerged as one of the most favored new options being discussed in Washington and on Wall Street. The appeal is that it would directly address the worries that banks have about lending to one another and to other customers.

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This new interest in direct investment in banks comes after yet another tumultuous day in which the Federal Reserve and five other central banks marshaled their combined firepower to cut interest rates but failed to stanch the global financial panic.

The gloomy market response sent policy makers and outside experts scrambling for additional remedies to stabilize the banks and reassure investors.

One concern about the Treasury's bailout plan is that it calls for limits on executive pay when capital is directly injected into a bank. The law directs Treasury officials to write compensation standards that would discourage executives from taking “unnecessary and excessive risks” and that would allow the government to recover any bonus pay that is based on stated earnings that turn out to be inaccurate. In addition, any bank in which the Treasury holds a stake would be barred from paying its chief executive a “golden parachute” package.

Treasury officials worry that aggressive government purchases, if not done properly, could alarm bank shareholders by appearing to be punitive or could be interpreted by the market as a sign that target banks were failing.

At a news conference on Wednesday, the Treasury secretary, Henry Paulson, pointedly named the Treasury's new authority to inject capital into institutions as the first in a list of new powers included in the bailout law.

“We will use all the tools we've been given to maximum effectiveness,” Paulson said, “including strengthening the capitalization of financial institutions of every size.”

The idea is gaining support even among longtime Republican policy makers who have spent most of their careers defending laissez-faire economic policies.

“The problem is the uncertainty that people have about doing business with banks, and banks have about doing business with each other,” said William Poole, a staunchly free-market Republican who stepped down as president of the Federal Reserve Bank of St. Louis on Aug. 31. “We need to eliminate that uncertainty as fast as we can, and one way to do that is by injecting capital directly into banks. I think it could be done very quickly.”